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Back To The Gold Standard? Only In Steve Forbes's Dreams

February 18, 1996

Economic Viewpoint

BACK TO THE GOLD STANDARD? ONLY IN STEVE FORBES'S DREAMS

Would-be President Steve Forbes has spent himself to the top of the Republican contenders. His bold promotion of the flat tax, the next best thing to no tax, has excited the interest of all those fed up with Washington politics, big government, oppressive taxation, winter snow, and middle age. Yes, it would be nice to have low taxes. But the flat-tax proposal can go nowhere. Cleansed of sacrosanct exemptions such as home-mortgage interest, the tax rate required in a flat tax is too high for the middle class. End of story. In the meantime, until people figure it out, the flat-tax idea will keep Forbes going in New Hampshire and beyond.

If the flat tax has a certain economic appeal, the same cannot be said of Forbes's second leg--the return to a gold standard. True, President Reagan established his right-wing credentials by dangling the return-to-gold prospect before his constituency. Whether gold was the right answer or not, at the time--in the late '70s and early '80s--the idea was worth weighing. Inflation was high, the dollar was unstable, and there was a serious need to bring back sound money. After his election, the President appointed a commission to study a return to gold, and there were hearings. Some gold nuts had their 15 minutes of fame before Congress, and the whole affair was quietly buried.

NO SUPPORT. Now, with inflation low after falling for more than five years, currencies relatively stable, the dollar rising, and unemployment below 6%, there is again talk of a gold standard. But who but a gold bug would think of bringing gold into the discussion of current policy, when deflation appears as much of a threat as inflation?

U.S. monetary policy has had its critics. Back in the '70s, Milton Friedman tirelessly knocked the Fed for its constant fine-tuning, which more often than not generated inflation rather than long-term growth. The Fed was more worried about recession than inflation, and its policies tended to err on the side of expanding money. But Friedman was the first to debunk Reagan's gold proposal. I am not aware of any single conservative monetarist economist coming out in support of gold.

There are many schemes around that purport to "fix" the Fed. There are rules for monetary aggregates, targets for stable price levels, and whatnot. Today, moving to a gold standard seems to any and all a completely offbeat idea that offers more problems than solutions.

The case for gold always has rested on two arguments: Gold, because of its limited supply (unlike paper money that can be printed day and night) commands a stable purchasing power over time. Hooking the nation's money to gold takes away the discretion of central bankers to print money--and substitutes in its place a naturally stable anchor.

POLITICAL FORCES. But several facts stand in the way of the gold myth. First, gold does not have a stellar record in terms of stability. South African, Russian, Asian, and Middle Eastern politics play a significant role in the price of gold. One reason gold is up to $417 an ounce is China's recent threat to invade Taiwan. Second, tying the U.S. to gold would not stabilize currencies unless our chief trading partners did the same. Germany isn't interested. It doesn't have an inflation problem, just as we do not.

Forbes argues that a move to gold would instantly lower interest rates by up to 200 basis points because the prospect of inflation vanishes. But what about deflation, a curse of the world economy when it was on the gold standard in the 19th century and during the Great Depression? Over the past decade, the U.S. has shifted from a high-inflation to a low-inflation environment. Interest rates are starting to reflect that fact, though there is some room to go.

It would be a costly exercise, with uncertain payoff, to experiment by entering a gold standard, simply because of promises of even less inflation. If we as a nation want to shoot for zero inflation, we can try passing a bill instructing the Fed to focus only on price stability, rather than employment as well as inflation. Set a reasonable framework for the transition so that growth isn't harmed. And create rules on how to deal with exceptional disturbances. Before Congress is a bill from Senator Connie Mack (R-Fla.) that does just that.

Forbes is a new kind of populist. He promises heaven on earth--low taxes and stable money--while trying to sweep away government, the Federal Reserve, common sense, and compromise. He wants a hookup with gold in the age of the Internet. In the end, none of this will happen, fortunately, and the U.S. will continue to enjoy low inflation, high employment, and steady growth.BY RUDI DORNBUSCH